3 questions every stock investor needs to answer

JonathanClements

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Are you better than most people at interpreting these numbers? If not, read on.

Investors are worried about rising interest rates, and yet rates are lower than at year-end 2013. Folks fret that stocks are overvalued, and yet the broad U.S. market is up for 2014, despite the recent turmoil.

We are, alas, constantly blindsided by the markets. We don’t know what economic and political developments will hit us next. We can’t be sure how other investors will react to these developments. And—let’s be honest—our own thinking is often less than rational.

How can you keep yourself on track amid all the market turbulence? Try asking yourself three questions.

1. What information or insights do I have, that others don’t, that make me think I can outsmart the market?

There are two ways to beat the market. First, you can uncover information that isn’t broadly known by investors. This is tough to do, unless you’re trading on insider information, which is illegal.

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Second, you could do a better job than other investors of analyzing public information. You might conclude, for instance, that U.S. economic growth will be slower than most folks anticipate or that other investors are overly glum about the prospects for emerging-market stocks.

But what are the odds that you’ll be right? The markets are dominated by professional investors who are better trained, better informed and more experienced than you and me. We’re highly unlikely to outguess them.

2. What can I confidently say about investing?

If we load up on a particular stock or market sector, it’s pretty much like flipping a coin. Maybe we’ll call heads correctly—or maybe not. There’s scant reason to be confident in our ability to pick winning investments. So what can we be confident about? For the thoughtful investor, there are some unexciting but useful truths.

Among them: Diversifying broadly reduces the chance that we’ll be badly hurt by any one investment, while improving the odds that we’ll make money over the long run. Most active managers lag behind index funds, which simply seek to replicate the performance of the market averages. Regular rebalancing keeps our portfolio’s risk level under control.

Other truths: Cutting investment costs helps us keep more of whatever we make. Holding down our portfolio’s tax bill, whether by funding retirement accounts or favoring tax-efficient investments in our taxable account, can also leave us with more money in our pockets.

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